As the AAPL Turns: Street Ponders Units, Margins and Leadership

By Tiernan Ray

If today is Thursday, which it is, it must be time for another look at the Street’s latest views on Apple (AAPL).

The stock today is down $3.05, or 0.6%, at $503.04. A piece by MarketBeat‘s Steven Russolillo this afternoon ponders whether perhaps the ongoing weakness in the stock is attributable to short sellers: “The amount of Apple shares sold short increased to more than 21 million in mid-November, the highest level since November 2008.”

Apple reports fiscal Q1 results next Wednesday, January 23rd, after market close. The Street is currently modeling $54.9 billion in revenue and $13.45 per share in profit. That revenue number is actually up from what it was at the end of November, when consensus was $54.78 billion, though it is down slightly from the view at the end of September for $55 billion.

Analysts continue to ponder the implications of speculative reports over the weekend that Apple cut production for the iPhone for the current quarter, reports that prompted some estimate cuts the last few days, but also a vigorous defense of the stock from some Apple bulls.

Today, there’s a mix of both, once again:

Mark Moskowitz, JP Morgan: Reiterates an Overweight rating, while cutting his price target to $725 from $770. Moskowitz is not worried about the iPhone based on the recent news reports, writing “We believe that the supply chain adjustments likely are related to Apple pulling back on double ordering of components as a result of manufacturing yield improvements.” He reiterates a 47.9 million-unit estimate for last quarter. But he cut his year iPhone outlook to 172.8 million units from 175.9 million, based on the timing of European carriers’ roll-out of LTE broadband wireless service. He thinks supply constraints tempered iPad sales last quarter. His iPad estimate last quarter goes to 18.4 million from 20 million, and gets cut to 78.9 million units from 81.2 million this year. As iPhone yields have improved, it’s possible “Apple’s consolidated gross margin could recover more quickly than anticipated by investors,” perhaps back toward 40% versus the most recent company forecast of 36%. Higher gross margin prospects may repair confidence in the stock, he thinks. So might an expansion of the payout ratio, as Apple is still “generating substantially more cash than it needs on a quarterly basis.” Although the set-up for the stock is “attractive,” writes Moskowitz, he cut his target to reflect “a reduction in valuation multiple ranges to reflect bruised investor sentiment.”

Bill Shope, Goldman Sachs: Reiterates a Buy rating and a $760 price target, writing that although he’s modeling below consensus for last quarter, at $53.58 billion in revenue and $12.58 per share in net profit, there is room for “upside” based on iPhone sales, which he’s been modeling at 48.4 million units. “Given the healthy supply ramp for the iPhone 5 and what we believe was remarkably strong demand, our ASP and unit assumptions could prove too conservative.” Shope lays out the possible scenarios for next week: “Given the remarkable compression in investor sentiment over the past several months and the increasingly intense battle between bears and bulls, we believe it is clear that this quarter will be a critical event for the stock. On a short-term basis, we believe investors are considering three general scenarios for the print: (1) Apple reports healthy December quarter upside, but issues typically conservative guidance that is below the current March quarter consensus; (2) Apple reports substantial upside (5%-plus revenue beat, with EPS of $15-plus), and conservative guidance that is near current March quarter consensus estimates; or (3) the company reports an in-line quarter or a slight miss versus consensus revenues and EPS, with conservative March quarter guidance that is below the current consensus. In the first scenario, the stock would likely have found a healthy bottom and the bull case can start to gain some steam over the next several weeks; there would still be a debate, however, over whether the March quarter guidance was conservative or whether it justifies recent concerns over iPhone demand trends in early 2013. In the second scenario, Apple’s outperformance would likely substantially damage the bear case and the stock could begin a sharp rebound immediately. And finally, in the third scenario, the bear case would likely gain steam and the stock may face further pressure in coming months. We believe the first scenario is most likely, as we believe the company has the potential to beat consensus iPhone unit and overall gross margin estimates.”

Kulbinder Garcha, Credit Suisse: Reiterates an Outperform rating on the shares, and a $750 price target. He thinks consensus for last quarter is too low and is modeling $57.2 billion and $14.59 per share, and gross margin of 39.3%, on 49.8 million iPhone units. Garcha thinks the media reports over the weekend were accurate, but didn’t point to a demand problem: “We believe the recent and consistent reports of iPhone order cuts are on balance accurate (i.e. that builds may fall 30-40% qoq in Q113). However equally we believe that they are not reflective of end demand and are evidence of Apple ramping its supply chain more aggressively than the past as the product cycle accelerates. Specifically we believe strength in smartphone shipments at Verizon, ATT a decent launch weekend in China support our 49.8mn estimates up 85% qoq and 34% yoy.” Garcha also has a rather high iPhone number for the current quarter, 44.8 million. Garcha predicts Apple had a strong quarter for the iPad as well, and will maintain majority share of that market: “We forecast 23.8 mn iPad units (70% qoq/+55% yoy) in F1Q13. Within the competitive landscape, we forecast Apple’s tablet share at ~59% in 2013 and ~50% long-term, though this may prove conservative given the company’s compute advantage, aggressive pricing and superior margin structure.”

On the other hand, Town Hall Investment Research‘s Jamie Townsend today reiterates an “Avoid” rating on Apple shares, writing that “We continue to believe that on a long term basis Apple will be unable to remain above the competitive fray and that its relative growth rates and margins will fall short of investor expectations.”

Townsend cites a report from ABI Research, put out today, that predicts that Apple will be playing second fiddle to Samsung Electronics (005930KS) this year: “Barring an unlikely collapse in Samsung’s business, even Apple will be chasing Samsung’s technology, software, and device leadership in 2013 through the foreseeable future,” according to ABI analyst Michael Morgan (emphasis in original).

The firm predicts “Apple’s market share is expected to peak in 2013 at 22%” of the smartphone market.

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There are 22 comments

JANUARY 17, 2013 3:53 P.M.

Ron wrote:

Who cares what these A holes have to say! Throw some more darts as the circus is out in full force this week.

JANUARY 17, 2013 3:55 P.M.

Jack H. wrote:

Tiernan, Apple is stuck in options expiration purgatory. There's roughly 1 million calls over $500 expiring tomorrow. Watch these MM's keep Apple at ~$500 through late tomorrow afternoon. It would be great for you to explore more about the impact of options on a stock like Apple, especially with a huge Opex month like January coming to a close. Watch it fly next week.

JANUARY 17, 2013 3:57 P.M.

Joe wrote:

Like I said last week, Tim Cook couldn't lead a group of Boy Scouts! He sux at his job and has completely ruined Apple and destroyed the very company the Steve Jobs Built! Cook will be fired on earnings night.

JANUARY 17, 2013 3:58 P.M.

John wrote:

The speed of Apple's innovation has definently slowed down. What is the real worth of current Apple's valuation is in the air. The next earning report should provide some guidance.

JANUARY 17, 2013 4:01 P.M.

Tim wrote:

Markets are soaring and as usual, Apple and Tim Cook can't find their asses from their elbows. Sad day, sad week, sad year for Apple shareholders. You have a Pussy running Apple. What you need is a CEO with brass balls. Sorry Longies.

JANUARY 17, 2013 4:02 P.M.

boxerconan wrote:

Please take a look at ABI Research's track record. They have an office in Seoul and possibility of who pays for their work. Seriously....

JANUARY 17, 2013 4:16 P.M.

Danny wrote:

To Jack or anyone that can answer this...What do you mean option expiration purgatory? I have heard this before many times or something similar to it. How do the Options MM's keep AAPL at bay for LEAPS? Can someone please explain what this means or where I can look up this information?

JANUARY 17, 2013 4:22 P.M.

Anonymous wrote:

Apple needs to be more assertive in terms of maintaining its image (rather than just sitting there taking the hits) and it needs to roll out updates that are more than just incremental in nature. If Apple doesn't come out swinging this year, the public's perception of Apple products may start to dim (even if such a view is not warranted).

JANUARY 17, 2013 4:43 P.M.

Jake_in_Seoul wrote:

@Jack H I realize you are expressing an overwhelmingly popular point of view, one so prevalent I also hesitate to weigh in with another viewpoint, one based I hasten to add on great support for AAPL and years of options trading, including ten years of trading AAPL LEAPS. The vast internet investing community does not understand options market making and (understandably perhaps) fail to appreciate the most important point: for every long option holder, there is not necessarily a counter-party holding the short option. In particular, the losses of long LEAP holders does not necessarily (or even usually) mean a gains for market makers. When I buy say, a call option, particularly one this is long-dated and deep out of the money, there may well be no seller at all that day. But the market maker still has to sell it to me. What do they do? Use derivative sleight of hand and create one out of thin air, sell it to me, while (this is the important point) hedging their own exposure to neutrality through the use of synthetic stock ( +call = +stock + put) using a ratio appropriate to their exposure via the Black-Scholes formula. As a result, purchases of call options forces the maker maker to buy stock, and in the mirror transactions, purchases of puts forces the market maker to sell stock short, all in the cause of remaining "delta" neutral. When calls or puts are cashes in, the reverse happens, so at this time of year call LEAPS being cashed in prompts market makers to sell stock, thereby pushing the market down. [I'm apologize if all this unclear or see overly basic, there's a vast range of expertise out there]

Now the important point is this: savvy hedge fund *know* in advance that in years when there has been a massive appreciation of AAPL price, that LEAPS will be cashed in, guaranteeing a flood of shares sold by the market makers in response. In short, certain downward pressure. They can then game that built-in pressure and exacerbate it through various schemes, such as" fomenting" bad news, forcing LEAP holders to sell and triggering a cascade down, thereby benefitting their short position.

TL;DR Hedge funds, not market makers are the villains around LEAP expiration.

JANUARY 17, 2013 4:45 P.M.

ILove EricS wrote:

@Danny: you can see the open interest for option contracts on most quote screens. Remember, each contract is linked to 100 shares when determining the number of actual shares the open interest controls. The point is that somebody sold these contracts and collected the dosh. That "somebody" is typically NOT individual investors or smaller players but rather large institutions. If those contracts expire out of the money, then the seller has no obligation to the buyer of the contract, hence the collected dosh remains in the hands of the seller. By suppressing the share price, more calls expire worthless, hence more profit is made by the sellers (mainly the guys these analysts work for). Jan probably has the most open interest of any month of the year for AAPL for several reasons...

@ILove EricS With all due respect you are passing on misinformation. For options, buyers are not necessarily equal to sellers. When I bought a bunch of AAPL 350 call LEAPS two years ago, there was likely not a seller at all.

Rather the market maker just did his home-brew synthetic stock (using the Madoff market-maker exception) and sold it to me, passing off his own risk to stay "delta neutral".

Any market maker who takes sustained positional risks would soon be out of business due to all the weird things that can happen. They stay neutral and work the spread.

JANUARY 17, 2013 5:01 P.M.

ILoveEricS wrote:

"there was likely not a seller at all."

Really? Explain how I can own a contract and nobody sold it to me...

JANUARY 17, 2013 5:03 P.M.

Danny wrote:

@ILove..I understand this part but I might not be understanding all of it....would this be neutral if the there was the same amount of puts vs calls on expiration day not have the effect that you describe?

PS I'm at a panic stage right now and don't know what to do and want to jump over my own cliff..I bought 200 shares at 607 and Im hurting right now really bad...I want to get out before earnings but Im too scared to do anything right now...I should have never got in this stock to begin with

JANUARY 17, 2013 5:23 P.M.

ILoveEricS wrote:

@Danny: it is not a requirement that for every call contract there is an "offsetting" put contract in existence. Haven't looked at the numbers, but I would bet that a whole bunch of people got long through call purchases in the Summer/Fall when everything was looking rosy, and once the institutions saw this large overhang of open interest, they start up the BS "analyst" soapboxes and short selling to drive down price artificially and gain from this. Its become a time-honored tradition for this stock since 2008. Imagine the pile of shite in these institutional guy's pants if Apple announced last week an immediate major repurchase program with its cash to prop up the price back to $700 before earnings announcement ? THAT would be awesome, but of course we have financial neophytes and wallflowers running the company so forget that idea.

This isn't to say that every brokerage/bank/hedge fund has the same strategy or objective (as Seoul pointed out, there are many ways to generate profits through "synthetic" structures). But at the end of the say it isn't hard to imagine that those with loads of cash and outstanding (short) derivative interests would be motivated to use their cash to create a favorable outcome for their situation, especially when its this easy (ie. make up some new garbage like all the other garbage in the past that was BS and watch the stock fall 30%. Easy, done.).

If I were you, I would hold my shares until after earnings...my opinion is that 90%+ of the "information" coming off "the street" and the business press is a total bunch of garbage made up to either a) supplant their position as described above, or b) generate a bunch of clicks to a website. Nothing about Apple's business has changed from the Summer/Fall except for a lot of contrived messages that teenagers could make up. Samsung? Whatever...those guys are clowns. If they are Apple's biggest threat, I'm not concerned one iota. The minute Google tires of making no money on Android, watch where Samsung ends up (see: Dell).

JANUARY 17, 2013 5:46 P.M.

Danny wrote:

@ILove As you state how would that matter since the volume on the options exceed the open interest..Also how would the selling pressure be relieved as you state

JANUARY 17, 2013 5:48 P.M.

Jake_in_Seoul wrote:

@ILoveEricS Here's a rough outline of what I'm trying to say. But for the rest, read up on options market making, synthetic stock, delta neutral, conversions, and reversals.

Standard internet understanding of options market making: massive, immoral MM sells call and puts with abandon, raking in cash and hating to pay any of it out if avoidable. So, as a general operating principle, the MM manipulates the stock price around expiration to maximize his cash haul by "zeroing out" the best combination of calls and puts. During LEAPS season for AAPL, rather than being forced to pay out all the money for appreciated options, now deep in the money, the evil MM works to plunge the price down, down, down so he can keep it all. Slight exaggeration, but that's about it, right?

How things really work (in my understanding): market makers are like casino operators or bookies. They hate taking risks, because in the long run, they know they'll be wiped out by a sudden war, new invention, hurricane, whatever. So, they hedge, hedge, hedge and take the house spread. Because options are derivatives, unlike stock, they can be easily created. And they are related to stock through the famed formula Long stock = Long call + Short put
So, when, say, call options are purchased, if no seller out there is available, the market maker does it himself, selling you the call, getting the money and buying AAPL stock and (sometimes) long puts in the perfect ratio calculated by the Black-Scholes formula, so that he will have no market exposure, no matter what happens. If the market goes up, he can pay you back if you sell the option, if it goes down he can pay you back. This is the so-called delta neutral position.

So, the evil market maker thesis makes no sense to me. But IMO the evil hedge fund manager does. They can take long or short positions in size and act to defend them (including through fomenting bad news) and most crucially, unlike 99% of the investing public, they have a deep understanding of the complicated interactions between option pricing and the underlying security pricing that happens at expiration. It is far from intuitive and their are entire books written on how best to game the last few days of an expiration cycle.

Sorry if this is not clear. Normally I've given up trying to introduce these issues as the MM as evil conspirator view point has become ingrained in investors' worldview. Nothing I say seems to change it. I would say, though, if you are investing for a living you owe it to yourself to understand options market making in depth.

JANUARY 17, 2013 5:53 P.M.

ILoveEricS wrote:

@Jake: I don't think it is safe to assume that a) there is only one formula people/institutions use to make money with options and b) that "evil MM" and "evil hedge fund" are necessarily different people/parties.

JANUARY 17, 2013 6:00 P.M.

Fear and Greed wrote:

Yep AAPL is doomed, only $55Billion revenue and $13.5 EPS for the QTR, about a 26% profit margin. Sell this loser and buy FB or AMZN or NFLX.

JANUARY 17, 2013 6:23 P.M.

Jake_in_Seoul wrote:

@ILoveEricS Not sure I implied there was only one formula used to make money with options, if so, sorry, of course not true at all.

But, conflating options market making with hedge fund maneuvering using options is risky in my opinion. The market making operations have to stand on their own, with their own accounting, and taking vast positional risks would be the quickest route to bankruptcy.

More fundamentally, demonizing (in my opinion) the market makers (e.g. concerning pinning, which is a natural market phenomenon) leads to a classic paranoid style of investing mentality that can cloud judgement and lead to major investing mistakes around, e.g. expiration.

So based on the news and word that's going on in Taiwan, my friends that just came back to the states from Taiwan are telling me that demand for iPhone 5 has been very stagnant. There's not that many people visiting the Apple stores in Taipei that are interested in the latest version of the iPhone. The iPad Mini however, has been selling like hot cakes. But not so much the iPhone 5-- reasons being apparently many folks do care about the screen sizes being smaller to the competitor's Samsung. Now, between a Samsung, Apple, HTC, Sony, Taiwanese folks would choose the latter three just because Samsung is a direct competitor to all the component firms on the island and for pride issues. That doesn't mean that there aren't more and more people appearing on the streets with a Samsung Smart Phone. So, Apple seriously needs to pick up its slack in the innovation area and stop revamping its old products. This probably can only go on for another version or two. Al Gore just executed his options on Thursday. Two possibilities he would do this: 1). uncertainty, expects Apple trend/demand to start waning 2). just plain needs the money for some other investment, taking out a portion of his options. I would like to believe in scenario 2 yet we can never leave out the possibility of scenario 1. 'Specially why would a board member execute shares 4-5 days before earnings. So I am expecting very mixed earnings report and hopefully it will skew towards the positive side but likely, this stock will just continue in a trading range despite better than so so reports.

JANUARY 18, 2013 9:48 A.M.

NYCLAW799@yahoo.com wrote:

Note on the Monday and Friday reports from Nikkei in iPhone and then on Friday iPad component cuts:
Just saw a note from the New York US attorneys office that they and the SEC will we cooperating with Japanese authorities in investigating possible US securities violations in Sharp/Apple and others, in addition to their ongoing investigation of analyst channel checks as insider trading.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.